Which statement is true about the circular flow diagram of an economy?

• A. It shows only the flow of money between the government and foreign sector.
• B. It excludes the role of markets in the exchange of goods and services.
• C. It demonstrates that households are the only producers in the economy.
• D. It illustrates the interactions between households and firms in markets for goods and services and factors of production.

Answer: (D)

Verified step by step guidance

1. Understand that the circular flow diagram is a model that represents the interactions between different sectors of the economy, primarily households and firms.
2. Recognize that the diagram includes two main types of markets: markets for goods and services, and markets for factors of production (like labor, land, and capital).
3. Note that households provide factors of production to firms and receive income in return, which they then use to purchase goods and services from firms.
4. Acknowledge that the circular flow diagram does not focus solely on money flows between the government and foreign sector, nor does it exclude markets or misrepresent who produces goods and services.
5. Conclude that the correct statement is the one that highlights the interactions between households and firms in both markets for goods and services and factors of production.